Recently read a news item that inflows from ULIPs to stock market could be around $15bn in 2009. Great news that so much money is coming in to the markets . But the sad part is so many investors have taken an uninformed decision of investing in equity through the wrong route.
A significant portion of premium money goes into paying hefty commission to insurance agents and other costs and Insurance is clubbed along with investment to hide all these costs.
I wouldn't only blame the agents. Investors also should try to do a basic analysis before they put across their hard earned money into such costly products. ULIP may definitely give returns but unfortunately not the full return that the investor deserves.
High time IRDA does something like the SEBI, by waiving the unnecessary entry loads.
Read the following articles if you need more insight on ULIPs
ULIPs are Unit Linked Insurance Policy
best performing ulips,which ulip to invest in, should i invest in ulip?,ulip as a financial product,is ulip a good investment?,ULIP vs ELSS, ULIP vs ELSS mutual funds, is it safe to invest uin ULIP, ULIP as a tax saving investment option.query ULIP vs SIP, ULIP VS MF,ULIP vs MF which is the best?.Queries on income tax. should I invest in ULIP to save tax are ULIPS better than insurance,better performance results,ULIPs vs Mutual Funds: Who's better? ULIP/MF,ULIP or MF, india stock muitual fund ipo ULIP SIP blog


Anonymous said...

Yaa, I happened to be cheated by Baja Allianze with their New Unit Gain policy with an entry load of over 50% while the New Unit Gain Plus entry load was only around 20%, both policies launched at the same time, with the clear intention of the Insurer o cheat the clients. ULIP's are a farse , and if at all it is better to stick with Insurers with proven integrity like LIC,HDFC standard, AIG, etc.than the crooks like bajaj.

Debt Consolidation said...

This is a GREAT blog...thanks for sharing!

Deb said...

Yes, a lot of mis-selling goes on in the insurance space, since agents feel they don't have to go back to the customers once the policy is sold. Lately, it seems the private life insurance companies (PLIs) have finally realized the importance of renewal premia (ref. ET 9-Mar-09 ‘Ulips add premium to life insurance renewals’). The other day at the Economic Times insurance conclave, the head of one of the PLIs indicated that the industry perhaps had a misplaced emphasis on new business, and new measures of performance need to be evolved. In another context, critical today in view of current liquidity problems in which almost all enterprises find themselves in the current economic environment, a host of mavens and industry experts have emphasized the need to conserve cash and in fact wring the last drop of cash out of operations (ET Mar-08 ‘Show Me The Money’).

I remember a post-railway budget public session on TV taken by the Union Railway Minister Mr. Laloo Prasad a few years back. To widespread mirth, he shared the homegrown wisdom that ‘you need to milk your cows to the fullest extent possible’, in the context of the phenomenal rise in the profitability of the Railways. Laloo did become the toast of the management community, with appearances before IIM and Harvard students, though the source of his management insights remains a mystery (does he have a speech writer par excellence?!). However, many did not catch on to a specific aspect of the wisdom above, perhaps due to the then relaxed liquidity environment, viz. the need to get out in the open the liquidity hidden in many stages of the process. Sounds familiar? (see above).

Back to the insurance industry. How much emphasis do PLIs put on the realization of the second (and subsequent) premium? Perhaps much less than that on the first year premium. To be fair, at the corporate level, there are measures to track something called ‘persistency’ and ‘conservation ratio’, which most PLIs track religiously. And the ratios are quite encouraging for many PLIs, mayby 75% or more. But what about the balance 25%? Is there a source of hidden cash there. And do these measures translate to concrete action at the ground level to improve, the same way a fall (or ‘de-growth’) of a few basis points in new business does? Perhaps not.

Any why such disproportionate emphasis on first year premium as compared to subsequent year premiums? There are two ways of looking at it: from the PLIs perspective and from the ground level agent’s perspective. Yes, much as they may insist on complete synchronization between the aims of the company and the individual aims of the agents, the reality may point otherwise.

At the corporate level, most PLIs are running like mad trying to improve their rankings within the industry. And what are the rankings based on? Mostly on measures related to first year premium i.e. new business.

To the agent, and the other sales staff. How much commission does an agent get on first year premium: upto 35% depending on the type of polilcy! Times are good. It may be interesting to look at the trends in insurance commission over years in the more mature markets (India is one of the markets with perhaps the lowest penetration levels of insurance, both in terms of percentage coverage of total population and insurance premium as a percentage of GDP, which hover in the low single digits). But, coming back to the issue, how much is the renewal commission for the agent? Perhaps a low 5-7%. So where would the agent invest his time and energy – in getting new business or in following up with the old customers? Get the point!

So what does this lopsided commission structure encourage the agent to do. Obviously, like any rational human being, the agent would like to rake in the moolah while the going is good. And in this, s/he is ably supported by the whole sales infrastructure of the PLIs which, as we’ve seen enough, is attuned to maximization of new business.

So the main target of the agent while trying to ‘close a sale’ is somehow to get the customer to agree to go in for the policy and put the money down for the first year premium. Once that is done (and of course the policy is enforced after underwriting), the agent is assured of his commission. In fact, some may be on the way to unforeseen heights like the famed Million Dollar Round Table (MDRT)!

And do the agents tend to take a few short cuts in this pursuit? You bet. Let’s consider the selling process of a typical unit linked insurance plan (ULIP), since an overwhelming majority of the business of PLIs consists of ULIPs (the tide is turning the other way towards traditional or endowment plans lately, but only very slowly). Wider issues of the ability of a particular insurance plan to fulfill the financial goals of the customer are conveniently given the go by most of the time anyways. But the agents are also not beyond selling a regular (i.e. other than single year) policy to the client as virtually a single premium policy. The logic they give the customer is: pay the first year premium, and then sit tight. Even if you don’t pay the premia for the subsequent years, you’ll get a good return on the first year premium at the end of three years (the minimum period for which a policy must be continued, as per regulations).

What they conveniently omit to tell the customer is that the corpus represented by his first year premium may have depleted significantly during this time due to the charges which are front-loaded to the policy. And that the expected return on his (already depleted) portfolio would most probably not be enough to cover the depletion, leave alone come out with a profit over the premium paid. The customers, at least the more intelligent ones who take an active interest during the selling process and don’t go purely on personal equations with the agent (more on that later), could probably make this out if given complete information. But how many customers are aware of an animal called ‘allocation ratio’? Not too many one would guess. Because they were shown rosy pictures of sky-high returns in the booming market, sometimes projected on growth rates even exceeding those mandated for illustration purposes by IRDA.

IRDA recently seems to have caught on to this kind of mis-selling. It came out with the directive that in case the second-year premium on a policy is less than the first year premium (may perhaps also cover cases in which the second-year premium is not at all paid by the customer), the different between the two premiums should be considered as single premium (on which the agent commission is capped at 2%) and the excess commission paid on it (over the mandated 2%) should be recovered from the agent and credited to the account of the customer.

Now, some PLI representatives have come out with the apprehension that this may incentivise the customer to ‘blackmail’ the agents, by threatening not to pay the second year premium. One is tempted to say that such agents (who lure the customers into taking a policy by, uh, let’s say, not being completely transparent) deserve But this needs a reality check.

How many agents keep in touch with their customers after the first year premium is paid. There is a lot of sales talk of the PLI being a trusted financial partner of the customer. However, the only interface most customers have with the PLI is the agent, who is most probably acquainted, or even related, to him/her in some way beforehand. But once the first year premium is paid (and the policy enfoced), the agent most probably well nigh disappearance (some customers could say, like horns from the head of a donkey ‘gadhey ke sir sey seeng’! – any allusion to the customer being treated like a donkey is strictly unintended!).

We’ve seen that the agent does not really have a pecuniary interest in getting the customers to continue the policy by paying premia regularly. In fact, some of the less than scrupulous ones (is that a euphemism these days?) may even want the policy to lapse, as that may absolve them of the trouble of explaining the less-than-promised returns to the policyholders (if at all the customer manages to get hold of them).

I have a few policies of different PLIs. Regardless of which channel was used during issue of the policy, it is doubtless assigned to some agent. But do the agents follow up with me when I fail to pay a premium (I’m sure most PLIs share the defaulting companies data with the agents, or do they not?). Except for one, no. Most of the time, it’s the PLI’s call center agents who come back to me. And, most of the time, their talk is so similar to the pesky executives trying to sell me everything from personal loans, credit cards to travel options, that I switch off the moment the person begins to speak. Bottomline, this method of follow up would hardly persuade me to change my view (if I’ve not yet decided whether or not to pay the second- or subsequent-year premium that is) and pay the premium.

Transported to another context, this scenario looks alarmingly (you could even say scaringly) similar to the analysis of reasons of the origins of the current US (and World) banking and economic crisis. There were companies whose only job was to sell mortgages, often to sub-prime customers. The mortgages, ones sold, were bundled and sold off to (perhaps bigger) financial institutions. Then the i-bankers came in and, using esoteric financial jugglery involving SPVs and what not, transformed the mortgages (including a lot of toxic sub-primes) into securitized debts. These securities were then sold by the investment banks to a wide range of investors, inland and abroad. And, oh, the rating agencies played their role too, giving guilt-edged ratings to such mortgage backed securities (MBSs).

The interesting thing to note above is: probably none of the players in the whole chain had an integrated view of the whole process. The only aim of the front-end companies was to sell the mortgages; once that was done, they had made their money and exited the chain, for a particular customer, that is (sound familiar to insurance agents? you bet!). The others up the chain were just pass-through players who made money from individual steps of the process. And the end-investor, probably in some far away land, who was left holding the paper (later proved almost worthless) eventually, didn’t in most cases realize what was the worth of the paper, having relied totally on the integrity of the intervening players in the chain (who conveniently disappeared when the time came).

In this scenario, do you think the front-enders who created the mortgage would follow up with the customers if the payments (EMIs) stopped coming? Why should they? They had already sold off their interest in the mortgage and made their money.

Back to the humble (!) insurance agent. S/he has probably used her contacts to the hilt while selling the policies in the first place. So many of the customers would perhaps treat him as representative of the PLI when they have to take a decision regarding the policy, right. But is the insurance agent very willing to provide such financial advise when the need comes. In the light of factors outlined above, perhaps not. In fact, s/he would perhaps tacitly encourage a trend where the policies lapse (especially where it was a case of mis-selling in the first instance anyway), vicariously so that s/he is able to sell newer products to the same customer, and make money by way of first year commission on such new policies. So the whole concept of the agent being a trusted advisor to the customer (perhaps the reason why many PLIs loftily designate their agents as Agent Advisor) goes out the window.

One point though. Since many such agents have not invested the time and energy to become the trusted financial advisors of the customers, they would find it increasingly difficult to sell further policies. Much of their selling may have been based on showing dreams (some would say ‘sabz baagh’) of unheard of returns to the customers for ULIPs, based on the booming stock market. Now, with the market on a downward spiral, even the gullible customers would not fall for such dreams (the reason why many customers are now chosing traditional or endowment products, and why PLIs are coming up with more such policies). The new plans with ‘guaranteed returns’ could stem the tide some, but not always, and there is a whole lot of mis-selling going on in such plans as well so the customer is wary this time.

To the other end of the spectrum now. The PLIs probably have all these trends and data already with them. So why are they now putting more emphasis on realizing the second (and subsequent) year premia? One reason of course is that all industry performance measures and rankings are based on new business, as we’ve seen above. However, there is one more, more technical, reason.

By law (read: IRDA regulations), based in large part on industry prudential practices, PLIs (for that matter, all insurance companies) are required to invest most of the money received as premium into prescribed forms of investment. Which is logical, since this is policyholders’ money and should be used to earn returns for them. On top of that, PLIs are required to create ‘reserves’ in their books, at a certain proportion to the premia received depending on the type of policy. So PLIs actually “earn” very little out of the premia after the first year, only the prescribed administrative costs. No wonder they try to get the maximum first year premium and front-load all possible charges on that.

Most PLIs have a phenomenal ‘burn rate’ when compared to other industries in their initial stages. Most PLIs have to invest their own (or their principal investors’) money in establishing their business and taking it to a certain critical mass. In things like setting up new offices, building their sales channels by way of new staff, et al. In fact, most PLIs could be ‘losing’ money on each new policy issued, counterintuitive as it may seem. Insurance is typically a long-gestation business, with break-even periods typically ten years or longer.

This does not, however, discount in any way the importance of getting the liquidity concealed in the system out in the open. Insurance companies may not treat their unrealized premia as ‘receivables’ in the conventional sense of the terms as used by other businesses. If they did, they would realise that enormous amounts of money are held up in such ‘receivables’, and could reorient their thinking to increased efforts on realizing such ‘receivables’. Even the minor proportion of such premium realised (after investment & reserving) could enhance their liquidity significantly. And this, for many PLIs, could mean the difference between being quasi-self sufficient as far as their expansion plans are concerned, and running to their investors or principals frequently for more money.

And for the customer, an increased emphasis on subsequent-year business by the PLI should mean more hand-holding by their agent. The agent would, in such a scenario, perforce have to act more responsibly towards the agent, minimizing instances of mis-selling and ‘slam bang thank you mam’ kind of blitzkrieg tactics. This would, then, truly transform the insurance company from a distant, impersonal behemoth to a ‘trusted financial advisor’, in the form of an agent.

But all this requires concerted action on the part of the industry as a whole (a relook at commission structures?), the individual PLIs (looking at their performance measures) and the regulators (reserving structures?). Are we all upto the challenge?

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